In a sense, Real Estate Investment Trusts (REITs) are ahead of their time. The dividends of these corporate entities, which invest in mortages as well as commercial real estate - office buildings, apartment buildings, and malls - are taxed only once by Uncle Sam.
Now President Bush wants other corporations as well to escape the "double taxation" of their dividends. The tax package he proposed last week would exempt corporate dividends from the personal income tax, but not from the corporate income tax.
But REITs already can pass 90 percent of their "taxable income" tax-free to shareholders. So the Bush plan is not expected to give REITs a second tax break, and allow investors in these trusts to avoid paying personal income tax on their dividends as well.
"It highlights the benefit of REITs in the first place," says David Ferguson, investment manager of Mercantile Diversified Real Estate, a Baltimore mutual fund that invests in REITs. "They face only one level of taxation."
Investors, though, were startled at the tax news and more cautious. REIT shares dropped 2 percent, on average, last week before recovering somewhat.
"Any impact will be minor, especially given the low-interest-rate environment we are in now," says Dan McNeela, an analyst at Morningstar, a Chicago firm that tracks mutual funds.
The tax change - if it gets through Congress - leaves REIT investors no worse off than before. They will still get dividends that last year averaged a bit more than 7 percent of the amount invested. The blue-chip stocks in the Dow pay only 2.15 percent in dividends. And 10-year Treasury bonds yield about 4 percent.
Nonetheless, the relative advantage of REIT yields could tumble a bit. Those stocks that have been offering high dividend yields - such as Teco Energy, American Electric Power, Goodyear, General Motors, and J.P. Morgan Chase - were driven up in price last Monday by the prospect of tax-free returns.
Rather than buying REIT shares outright, many individual investors invest in them indirectly, through mutual funds. This has the advantage of diversification. Since most real estate mutual funds own shares in dozens of the 166 REITs that trade on major stock exchanges, bad financial news on a single REIT does relatively little damage to their investment.
In the past three years, REIT investments have done comparatively well. The average total return on equity REITs, those invested in buildings, came to 26.4 percent in 2000, 14 percent in 2001, and 3.8 percent last year. That reflects both the dividend yield of more than 7 percent in each of those three years and the change in the share price.
That positive return compares with a 9.1 percent decline in the Standard & Poor's 500 stock index in 2000, a 11.9 percent drop in 2001, and a 22.1 percent fall in 2002. Thus, investors in REITs likely enjoyed a good offset on losses in other corporate shares.
Those investing directly in REIT shares for income probably enjoyed a steady quarterly (or even monthly) flow of dividend checks that well exceeded most other income-type investments.
An investor in a REIT fund five years ago, a period including part of the stock-market bubble, would probably have seen his shares outperform the market nicely.
And, notes Paul Reeder, an analyst with SNL Financial in Charlottesville, Va., he would have slept better at night. "REITs are meant to be boring. You don't get an Enron-type meltdown."
REIT shares have much lower volatility than most stocks because the value of properties usually changes only slowly.
"People are buying these [real estate] funds for diversification from other investment sectors," says Mr. Ferguson. "Or they are buying for income." His fund had a 4.7 percent total return last year.
Historically, REIT share prices have a low correlation with the prices of other stocks or bonds. This aspect can be useful to companies that offer their employees 401(k) plans. These companies have a fiduciary responsibility to lessen the risk for employees of large losses by at least offering them a choice of more conservative investments, and that could include real estate mutual funds.
What are prospects for REIT investments this year? "They are decent, but not overwhelming," says Mr. McNeela.
Researchers at A.G. Edwards, a St. Louis-based brokerage, chose a bunch of high-dividend REITs they suggest could give a 3 to 7 percent return this year.
In general, the value of properties owned by REITs today matches or slightly exceeds the total value of their shares, experts reckon. But some REITs, the analysts note, have problems.
Those investing in office properties in some markets face declining rents. But most leases are for 10 years or so. The slow economy and surplus office space may be gone when many leases expire.
REITs invested in apartment buildings face another problem: Low-interest mortgages mean many tenants have been able to buy homes and move out. Those REITs invested in hotels are suffering from the weakness in the travel industry.
In general, however, REITs are slow to cut dividends. They usually have a cash flow that exceeds the amount they must pay out to investors - and dividends have accounted for 79 percent of the return on equity REITs since 1992.